Quick question on Revenue Recognition (IAS 18)

breddiek

Hi,

As part of college we were asked the following question regarding revenue recognition. It's an auditing module so we must give an opinion on whether this income is recognisable in accordance with IAS 18.

"Prior to the close of its September 30 fiscal quarter, a manufacturer(seller) completes production of 50,000 specialised gas valves. The valves sell for €60 each and were ordered by customers that assemble and sell gas fireplaces. The customers are unable to take delivery by Sept 30 for reasons that include: (1) lack of available space, (2) having ample inventory on hand to cover production for the next month, and (3) delayed production schedules. The seller segregates the valves awaiting shipment from other unsold products in its own warehouse and wishes to recognise €3,000,000 of revenue in the current quarter from these goods produced, but not shipped.
Required

Can the seller do this? Justify your answer."

My current thinking is that it cannot be recognized as seller retains continuing managerial involvement to the degree usually associated with ownership as well as effective control over the goods sold. Other than that condition I believe it meets all others. Could any auditor or accountant with knowledge of the IAS's shed some light on this for me?

Thanks.

myshirt

This is a rare animal and they really shouldn't be asking it. It is pure 'dick measuring', and bad question writing as it is commercially unrealistic. What they are trying to get at is a 'bill and hold' scenario. You can recognise it, on the basis it is recoverable, delivery probable, which I didn't see you mention. But be very cautious, and support your answer thoroughly discussing each recognition criteria in turn. Presumably profit being made here, client invoiced, agreed irrevocable in normal course of business etc.

Poor question from them.

PunkFreud

myshirt wrote: »

This is a rare animal and they really shouldn't be asking it. It is pure 'dick measuring', and bad question writing as it is commercially unrealistic. What they are trying to get at is a 'bill and hold' scenario. You can recognise it, on the basis it is recoverable, delivery probable, which I didn't see you mention. But be very cautious, and support your answer thoroughly discussing each recognition criteria in turn. Presumably profit being made here, client invoiced, agreed irrevocable in normal course of business etc.

Poor question from them.

I disagree, revenue cannot be recognised. Per IAS18 (Revenue), revenue can only be recognised when the risks and rewards of the goods have been transferred to the buyer.

In this case, as the goods remain in the seller's warehouse, the risks and rewards have not transferred. For instance if there was a fire and the goods were destroyed, then the seller would suffer the consequences - not the buyer.

Assuming already invoiced, this would be recognised as deferred income.

myshirt

When I am on my computer later I'll give you the references. The critical detail here is that the goods have been set aside and isolated, so as long as delivery is probable the revenue can be recognised.

It is a 'Bill and Hold' scenario, and it's a very rare animal, but it's fully above board. There was a similar question on the FAE last year, and I discussed it with an IFRS consultant at the time. I was told that it is an issue that standard setters have crossed swords on, and he is sure that a few headbutts were thrown in the development of IFRS 15.

This chap's examiner should not be asking him contentious issues that auditors would audit the bollox out of, and which is very rare.

myshirt

Totally forgot about this...

If you look at the document accompanying IAS 18 (the one with the illustrative examples), you'll see the first example which answers your question. This is the only link I could find, but I have the book myself https://goo.gl/qfbcTk

The key issue when considering your 'normal' revenue recognition criteria on this one is the sniff of continuing managerial involvement, as raised above. Let's assume the others have been met and there is no onerous encumbrances on the remittance of funds etc. As long as:

1. The item is on hand, physically exists, and has been set aside / put in a corner and marked for this customer
2. It is probable that delivery will be made
3. Buyer is on board with the deal - i.e delivery delayed at their request, tells you hold onto them, deliver them in a few weeks or whatever

In these circumstances, the transaction is a 'bill and hold' sale. As I said, it is a rare animal, and something that an auditor will perk up the ears to. In the states, they call it 'channel stuffing' I believe, as an auditor you would have to consider related party transactions and also audit the realisation of the sale post year end. Potentially more, I don't know, I am not an auditor.

Still believe the question they asked you op was a bit harsh, because the judgement that has to be applied is a sensitive topic and one on which a few headbutts were thrown on in the development of IFRS 15. Revenue recognition will always be a risk. The FRC are looking at Tesco and the audit of Tesco at the moment with the overstatement of their earnings there last year, I know that it is being reported as mostly being a cost journal that was approved at the board meeting, but I do believe that there is an issue in there in terms of Revenue recognition policy, there's a few people due a kick in the hole, so this issue op is possibly a very hot one, but not one I believe they should be lamping you with at this stage in your studies.

mackers87

Myshirt, you've made me think I definitely need to go back and look at IAS18 As I would have thought this was a straight 'No, shouldn't recognise' as the risk and rewards haven't transferred (e.g. fire or damage as someone mentioned). I wasn't aware of the example you mentioned above.